China could liberalise yuan by 2014, says BNY Mellon strategist

There are signs China is moving towards liberalising the yuan, says BNY Mellon currency strategist. Full convertibility will be a game changer for foreign exchange markets and cause the euro to fall.

China’s currency could be fully liberalised by 2014, which will be a game changer for the foreign exchange markets, says BNY Mellon’s Simon Derrick. He also believes this will be the point when the euro loses value in the foreign exchange (FX) market.

There are already signs that China is moving towards liberalising the yuan, according to Derrick, managing director, chief currency strategist. Another step supporting his forecast is that Sheng Songcheng, head of the statistics department at the People’s Bank of China (PBOC), recently created a three-step plan for loosening capital and foreign exchange controls over the next five to 10 years.

In April PBOC widened the daily trading band for the yuan against the dollar from 0.5% to 1% up or down. Then in May, Ba Shusong, deputy director-general of the Financial Research Institute in the State Council’s Development Research Centre, spoke about opportunities to move toward capital account convertibility.

“It was being discussed in public, which is a huge positive shift,” says Derrick. He thinks China has recognised the need to liberalise its currency because if it does not it will have to double its currency reserves over the next few years. “That is not a route it wants to go down,” he adds. By 2014 or 2015 the currency could be completely liberalised, according to Derrick.

This will be a turning point for the currency markets, he argues. “The point when China doesn’t have to enter the FX market every day is the day when it stops growing its FX reserves,” says Derrick.

At this point the value of the euro will finally fall because it is being kept high by China diversifying its currency reserves, he explains. “Most people suggest China’s dollar reserves have fallen from three-quarters to 60%. Others put it lower. The euro is big enough to accept these reserves. It helps explain so much about the euro performance over the last year.”

Using China as a barometer for what is happening in other countries, others could also be diversifying their currency reserves to include more euro reserves.

Every time the US starts a round of quantitative easing, China’s dollar reserves fall, according to Derrick. This happened in June 2009 and June 2010. If the Federal Reserve decides to introduce a third round of QE, China’s reserve diversification could pick up pace.

However, he says another round of QE in the US is unlikely. “I think if the Fed can afford to not do another round of QE, it won’t [do it] because it recognises the effects.” After August the Fed is unlikely to make any moves until after the election, he adds.

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